PartI

Introduction

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Chapter1WhyStudyFinancialMarketsandInstitutions?1

Chapter1
WhyStudyFinancialMarkets
andInstitutions?
WhyStudyFinancialMarkets?
DebtMarketsandInterestRates
TheStockMarket
TheForeignExchangeMarket
WhyStudyFinancialInstitutions?
StructureoftheFinancialSystem
FinancialCrises
CentralBanksandtheConductofMonetaryPolicy
TheInternationalFinancialSystem
BanksandOtherFinancialInstitutions
FinancialInnovation
ManagingRiskinFinancialInstitutions
AppliedManagerialPerspective
HowWeWillStudyFinancialMarketsandInstitutions
ExploringtheWeb
CollectingandGraphingData
WebExercise
ConcludingRemarks

Overview and Teaching Tips

Beforeembarkingonastudyoffinancialmarketsandinstitutions,thestudentmustbeconvincedthatthis
subjectisworthstudying.Chapter1pursuesthisgoalbyshowingthestudentthatfinancialmarketsand
institutionsisanexcitingfieldbecauseitfocusesonphenomenathataffecteverydaylife.Anadditional
purposeofChapter1istoprovideanoverviewfortheentirebook,previewingthetopicsthatwillbe
coveredinlaterchapters.Thechapteralsoprovidesthestudentswithaguideastohowtheywillbestudying
financialmarketsandinstitutionswithaunifying,analyticframeworkandanappliedmanagerialperspective.

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Chapter1WhyStudyFinancialMarketsandInstitutions?2

Inteachingthischapter,themostimportantgoalshouldbetogetthestudentexcitedaboutthematerial.Ihave
foundthattalkingaboutthedatapresentedinthefigureshelpsachievethisgoalbyshowingthestudentsthat
thesubjectmatteroffinancialmarketsandinstitutionshasrealworldimplicationsthattheyshouldcareabout.
Inaddition,itisimportanttoemphasizetothestudentsthatthecoursewillhaveanappliedmanagerial
perspective,whichtheywillfindusefullatterintheircareers.Goingthroughthewebexerciseisalsoawayof
encouragingthestudentstousethewebtofurthertheirunderstandingoffinancialmarketsandinstitutions.

Answers to End-of-Chapter Questions

1. Becausetheychannelfundsfromthosewhodonothaveaproductiveuseforthemtothosewhodo,
therebyresultinginhighereconomicefficiency.
2. Businesseswouldcutinvestmentspendingbecausethecostoffinancingthisspendingisnowhigher,
andconsumerswouldbelesslikelytopurchaseahouseoracarbecausethecostoffinancingtheir
purchaseishigher.
3. Achangeininterestratesaffectsthecostofacquiringfundsforfinancialinstitutionaswellas
changestheincomeonassetssuchasloans,bothofwhichaffectprofits.Inaddition,changesin
interestratesaffectthepriceofassetssuchasstockandbondsthatthefinancialinstitutionowns
whichcanleadtoprofitsorlosses.
4. No.Peoplewhoborrowtopurchaseahouseoracarareworseoffbecauseitcoststhemmoretofinance
theirpurchase;however,saversbenefitbecausetheycanearnhigherinterestratesontheirsavings.
5. Thelowerpriceforafirmssharesmeansthatitcanraiseasmalleramountoffunds,andsoinvestment
inplantandequipmentwillfall.
6. Higherstockpricesmeanthatconsumerswealthishigherandsotheywillbemorelikelytoincrease
theirspending.
7. ItmakesforeigngoodsmoreexpensiveandsoBritishconsumerswillbuylessforeigngoodsand
moredomesticgoods.
8. ItmakesBritishgoodsmoreexpensiverelativetoAmericangoods.Americanbusinesseswillfindit
easiertoselltheirgoodsintheUnitedStatesandabroad,andthedemandfortheirproductswillrise.
9. Changesinforeignexchangerateschangethevalueofassetsheldbyfinancialinstitutionsandthus
leadtogainsandlossesontheseassets.Alsochangesinforeignexchangeratesaffecttheprofits
madebytradersinforeignexchangewhoworkforfinancialinstitutions.
10. Inthemidtolate1970sandthelate1980sandearly1990s,thevalueofthedollarwaslow,making
travelabroadrelativelymoreexpensive;thatwouldhavebeenagoodtimetovacationintheUnited
StatesandseetheGrandCanyon.Asthedollarsvalueroseintheearly1980s,travelabroadbecame
relativelycheaper,makingitagoodtimetovisittheTowerofLondon.
11. Banksacceptdepositsandthenusetheresultingfundstomakeloans.

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3Mishkin/EakinsFinancialMarketsandInstitutions,SeventhEdition

12. Savingsandloanassociations,mutualsavingsbanks,creditunions,insurancecompanies,mutual
funds,pensionfunds,andfinancecompanies.
13. Answerswillvary.
14. Theprofitabilityoffinancialinstitutionsisaffectedbychangesininterestrates,stockprices,and
foreignexchangerates;fluctuationsinthesevariablesexposetheseinstitutionstorisk.
15. BecausetheFederalReserveaffectsinterestrates,inflation,andbusinesscycles,allofwhichhave
animportantimpactontheprofitabilityoffinancialinstitutions.

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Chapter1WhyStudyFinancialMarketsandInstitutions?4

Quantitative Problems
1.

ThefollowingtablelistsforeignexchangeratesbetweenU.S.dollarsandBritishpoundsduringApril:
Date

U.S.DollarsperGBP

Date

U.S.DollarsperGBP

4/1

1.9564

4/18

1.7504

4/4

1.9293

4/19

1.7255

4/5

1.914

4/20

1.6914

4/6

1.9374

4/21

1.672

4/7

1.961

4/22

1.6684

4/8

1.8925

4/25

1.6674

4/11

1.8822

4/26

1.6857

4/12

1.8558

4/27

1.6925

4/13

1.796

4/28

1.7201

4/14

1.7902

4/29

1.7512

4/15

1.7785

Whichdaywouldhavebeenthebestdaytoconvert$200intoBritishpounds?
Whichdaywouldhavebeentheworstday?Whatwouldbethedifferenceinpounds?
Solution: Thebestdayis4/25.Atarateof$1.6674/pound,youwouldhave119.95.Theworst
dayis4/7.At$1.961/pound,youwouldhave101.99,oradifferenceof17.96.

2012PearsonEducation,Inc.PublishingasPrenticeHall